Sustainability briefing | ESG, Business Ethics & Human Rights, Alternative Asset Management, Corporate & Commercial Disputes |

Holding asset managers to account

Holding asset managers to account

Overview

We recently held our third webinar in the series "Sustainability and alternative asset managers: the new normal".

This webinar, "Holding asset managers to account", featured a panel decision, chaired by Doug Bryden, our Head of Risk & Operational Regulatory, on the topic of litigation risk coming out of the ESG agenda, with a particular focus on the risk to private equity firms and asset managers.  Alongside Doug were Andrew J. Ehrlich and Audra J. Soloway of Paul, Weiss – both partners in the Litigation Department and the co-chairs of the Securities Litigation and Enforcement Group, and our own Heather Gagen, a partner in our Dispute Resolution department, who is experienced in advising clients in relation to large-scale, international and complex litigation and the management of ESG and business and human rights-related risk.

While noting the many positives that a focus on ESG credentials and activities can bring an organisation, the panel explored the associated downsides, including litigation, that can also arise - of which organisations may not be fully cognisant.  These types of risk are amplified by the commercial and regulatory pressure (seen on both sides of the Atlantic) to promote ESG and make ESG-related disclosures.  Businesses that look to engage with the ESG agenda need to consider carefully how they do this, to avoid becoming a target of ESG-related claims and/or regulatory attention. This note covers in detail the panel's discussion on these associated risks.

ESG trends and particular risk areas

As in many areas, social and political trends can inform how the litigation landscape evolves.  ESG is no different, and indeed a prime example of this pattern.  In the US, we are seeing increasing activity by plaintiffs, and the plaintiff bar, in bringing claims which are focussed on whether and to what extent corporations have "lived up to" their public statements on ESG issues.  We're also seeing increased regulatory focus: the SEC has announced a climate change related disclosures taskforce, and there is a wide range of views, both within the US Government and outside of it, as to how broadly or narrowly the SEC's intervention should be. 

Looking at some specific examples of ESG-related claims, we have already seen social trends such as #MeToo and an increased focus on diversity and inclusion as well as climate change, leading to numerous securities class actions and shareholder derivative actions relating to these types of issues.  While many of these cases have been dismissed, a handful have survived early motions to dismiss and resulted in large settlements.

In the UK, ESG litigation has to date been most prominently associated with (i) parent company liability claims and (ii) so-called "value chain" claims.  These claims are in vogue for a number of reasons.  The political and policy environment is in favour of holding UK-based corporate groups to account for alleged harmful practices (often related to environmental impact or human rights) in the overseas operations of their subsidiaries and/or in their global value chains.  Secondly, these types of defendants tend to have deeper pockets, and are therefore viable targets for this type of claim.  Moreover, the UK's legal regime provides a relative benign low or no risk costs regime for claimants bringing these types of claim, so there is an appetite to pursue riskier or novel causes of action.  And finally, recent decisions of the UK Supreme Court in the cases of Vedanta and Okpabi make it more difficult for defendants to dispose of these types of claims at a preliminary procedural stage. 

(For more on this, please see our recent client briefings on the rise of parent company liability claims and value chain claims.)

Interrelationship between regulation and litigation

As noted above, similar trends are being seen in both the litigation and regulatory landscapes.  The key link between ESG regulation and ESG litigation is ESG disclosures.  ESG disclosures may be mandated (by legislation/regulation) or they may be voluntary.  The implications of these disclosures are not always appreciated by businesses.  Some organisations see these disclosures as "soft" statements, and approach them on the basis that they are essentially corporate marketing/PR, without appreciating that these are the very statements which may be used against them  by plaintiffs/claimants in ESG litigation.

Multinationals have particularly felt the brunt of this over recent years.  Where their businesses have a global reach, and especially where they include subsidiary operations in challenging environments and emerging markets, group-wide ESG statements are being used in litigation as a means of trying to establish liability for a UK based defendant for what happens in all corners of its group's global operations.  This is the driver of much of the parent company liability claims and value chain claims that we're starting to see in the UK. 

It also needs to be remembered, as we see in both the US and UK, that even flawed claims which do not ultimately succeed, can carry substantial reputational and financial costs for defendants; and - those bringing them may see value in the attempt, even if the outcome is adverse.

This is not just a UK-specific issue either. The European Union (and member states within the EU such as Germany and France) are creating extensive ESG disclosure regimes and new laws to make it easier for corporations in the EU to be sued or fined for matters arising from the conduct of their operations overseas. 

(For more on the EU's supply chain proposals, please see our recent client briefing.) 

Why should private equity firms and asset managers be concerned about this risk?

Plaintiff and claimant law firms have the appetite and, increasingly, the funding to pursue novel and risky claims which push at established liability regimes. This is a pattern which can be seen, albeit developing in different ways, in both the US and the UK, as we've outlined above, as well as in many other jurisdictions. The number of high-profile companies in the hands of private equity continues to rise, and the number of IPOs remains relatively low. As more and more high-profile companies are held by private equity and major private equity firms become publicly traded, it is unlikely that asset managers will be insulated from these types of claim and their ramifications, whether directly or indirectly. In any event, private equity firms and their principals are at risk of becoming targets of shareholder litigation for many of the same reasons that corporations may become targets – failure to live up to ESG-related disclosures and falling short of regulatory expectations. ESG litigation risk should not be seen as a concern for "multinationals" alone: this is a rapidly evolving and innovative area of the law, that carries real risk for a wide range of businesses.

Beyond legal risk: reputational considerations

Antipathy toward private equity firms also provides a fertile landscape for a plaintiff or claimant law firm to control the narrative and issue a reputationally damaging claim against a private equity firm if they chose to do so – as has already been seen in the US. Political motivations can exacerbate this problem.

The reality is that ESG-related claims can cause real reputational harm to businesses, and this can incentivise early settlement. In the US, only a small fraction of certified securities class actions against corporations make it to trial, such is the pressure on executives to settle these claims out of court. Similarly, in the UK, none of the high-profile parent company liability claims are yet to make it to trial. Fuelled by the growing maturity of the litigation funding market, this creates a dynamic where reputationally damaging claims can result in a sizeable settlement at an early state of the litigation, and before the allegations are properly examined. Meanwhile, judicial commentary on these ambitious, and potentially flawed, bases of liability, has been largely confined to examination of the relevant principles in the context of strike out/dismissal motions, rather than following detailed argument and forensic testing of complex factual matrices at trial.

How should private equity firms and asset managers conduct their ESG-related activities and comply with their regulatory requirements, in a way that minimises their future litigation risk?

Businesses need to understand that the ESG agenda is not all about upside marketing gain. It should not be seen as a box ticking exercise. With active regulators and claimant law firms, businesses will be tested on what they say publicly about their ESG activities, and there may be exposure if – in practice – those public commitments have not been fulfilled. Equally, organisations may face litigation if they imply a greater degree of control or oversight of ESG activities throughout their group and/or value chains, than is in fact the case. From a governance perspective, this means that internal investment is going to be needed to monitor ESG disclosure and compliance. 

Businesses should certainly not be put off from engaging in ESG initiatives: the reality is that they may have no choice but to do so. However, they do need to think carefully about what they're doing and what they're saying.

In a private equity context, firms need to consider how much control they want in relation to the management of ESG activities and risk, and therefore how much exposure they have to this litigation or regulatory risk. It is important that firms are conscious about the degree of control (and therefore potential liability) they wish to take in such areas, balanced against the opportunities they may wish to take to enhance and oversee good ESG governance and risk mitigation practices. Further, when acquiring new portfolio companies firms may want to invest in a detailed risk-management exercise post-close in order to uncover potential risk areas.

General counsel should also feel empowered to stand-up to marketing teams. Unnecessary public disclosures contain real risk and claimant law firms may knit together decades of corporate statements to fit their litigation case theory and public narrative. Further, with the development of ESG regulatory regimes, plaintiffs may argue that ESG disclosures are as "material" as financial disclosures (e.g. P&L). By limiting what is in the public domain, businesses limit their exposure to ESG litigation. 

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